Our 2017 Midyear Wrapup condenses our coverage of major retail events and developments from the first half of this year.
Welcome to our 2017 Midyear Wrapup, which brings together our coverage of retail events, developments and stories from the first six months of 2017. Our team has had a busy first half, attending conferences and investor day events in the US, Europe and Asia, and covering a slew of news events and company updates.
In the US, the dominant tone so far this year has been pessimistic. The upheaval that established major retailers face has been amply documented, with store closures and bankruptcies making headlines almost every day. We have led coverage and analysis with our weekly US store closures report, and we include our latest data in this report.
The wider picture, however, has been far more diverse. The macroeconomic context in the US remains solid and retail sales in total are still growing robustly. Amazon announced its intention to buy Whole Foods Market and enter the Australian market; Lidl entered the US market and its sister chain, Kaufland, reportedly plans to launch in Australia; and Walmart has undertaken a series of acquisitions, including, most recently, Bonobos. This report discusses those topics, and wraps up our coverage of investor day events hosted by Macy’s, Walmart, Zalando and Alibaba Group as well as our coverage of this year’s World Retail Congress and Mobile World Congress.
We hope you find this wrap-up of our coverage of the first half of 2017 informative and interesting. Our daily reportage on retail and technology trends, events, and news can be found on FungGlobalRetailTech.com.
Amazon to Acquire Whole Foods for $13.7 Billion in Cash
On June 16, Amazon announced the signing of a definitive agreement to acquire Whole Foods Market for $13.7 billion in cash, which includes the assumption of roughly $1 billion in Whole Foods’ net debt.
The two companies’ statement included few details. Whole Foods CEO John Mackey said that the deal represents an opportunity for Whole Foods to maximize value for shareholders while “extending [its] mission and bringing the highest quality, experience, convenience and innovation to [its] customers.” Whole Foods will continue to operate under its own brand and Mackey will remain with the company.
The transaction, which is expected to close in the second half of 2017, requires approval by Whole Foods’ shareholders as well as by regulatory bodies and is subject to other customary closing conditions.
Creating an E-Commerce/Brick-and-Mortar Powerhouse
Whole Foods will bring $16 billion of grocery sales to Amazon. According to Euromonitor International, the chain was America’s eighth-largest grocery retailer in 2016. Amazon’s grocery sales were estimated to be $350 million in the first quarter of 2017, according to OneClickRetail.com; that equates to $1.4 billion in annual sales.
Amazon’s Acquisition History
The Whole Foods acquisition would be Amazon’s largest to date. The company’s acquisitions have averaged $520 million (excluding Whole Foods), based on the available data. Amazon has averaged about 4.5 acquisitions per year over the past seven years. A table of selected acquisitions is below.
Our Take: Admitting That Online Grocery is Not Enough
In the absence of any official word on the reasoning behind the purchase, we draw two primary conclusions from this move:
In short, this dramatic move shows just how serious Amazon is about pushing into newer categories.
Lidl US: Prospects and Impact
In mid-June, Lidl opened its first US stores. Here, we provide some answers to major questions about the retailer’s prospects and impact in the US market. This research was compiled before the company opened its first US stores.
Lidl US: Key Facts
What do we estimate Lidl’s US sales will be?
We see an approximate 1-2-4 structure to Lidl’s US sales: we estimate that the company will generate roughly $1 billion in US sales in 2018, $2 billion in 2019 and $4 billion in 2020. To put this in context, Kroger generated revenues of $115 billion in the year ended January 2017. However, revenues in the low single billions would place Lidl in the same ballpark as Ingles Market, which had $3.2 billion in sales in 2016; Sprouts Farmers Market, which had $4.3 billion in sales in 2016; and SuperValu, which had $4.8 billion in sales in 2016 (all figures are from Euromonitor).
Our estimates assume that Lidl will open just under 100 new stores per year.
What headwinds and tailwinds could Lidl face?
Lidl is not so much dipping its toes in the water as diving straight in—and it is doing so with a store format that differs from what it uses elsewhere in the world. We see the following risks associated with these decisions:
Meanwhile, we see three possible tailwinds that could drive Lidl’s growth:
Consumer interest in healthy living: Grocery retailers and analysts widely recognize that there is a trend toward healthier living, including increased demand for more natural products and fresh produce. If Lidl uses its additional store space to offer substantial fresh food ranges, as we expect it will, the retailer could be well placed to pick up shoppers looking for fresh and natural foods on a budget.
The frugality of millennial shoppers: Millennials—typically characterized as those born between 1980 and 2000—are entering their peak earning and spending years. And this generation shows significant price sensitivity in grocery, which we noted in a previous report, How Millennials Disrupt Industries: Millennials and Grocery. If Lidl gets its marketing right, it may be able to mop up some of these shoppers.
Incremental shifts away from superstore shopping: As more and more nongrocery purchases shift online, and as consumers’ expectations of convenience and immediacy in food shopping increase, there appear to be fewer reasons for shoppers to visit large superstores for grocery purchases. Lidl could benefit from any ongoing shift to smaller store formats that allow consumers to shop more quickly.
Which incumbent retailers look to be most at risk?
Below, we present data on selected grocery retailers’ overlap within the eight states in which Lidl apparently plans to open stores. The table provides store numbers that fall within the eight states for selected retailers, and the final row represents this as a percentage of these retailers’ total estates.
The data show that Weis Markets and Ingles Markets have, by far, the greatest relative exposure to the eight states in which Lidl is hiring. In absolute terms, Walmart and Kroger have the greatest number of stores in these eight states.
We do not have robust state-level data for Ahold Delhaize banners. These include Food Lion, Giant Carlisle, Giant Landover and Martin’s Food Markets, which are variously present in the eight states, with the exception of New Jersey, and Stop & Shop, which is present in only one of the eight listed states, New Jersey.
Understanding Aldi Shoppers to Understand Lidl Shoppers
We think one way to understand who will shop at Lidl is to look at who shops at Aldi in the US, given the similarity of the companies and their comparable focus on eastern states. For this, we turn to consumer survey data from our research partner, Prosper Insights & Analytics. Prosper’s survey asked consumers where they had shopped in the past 90 days, and the data enable us to isolate at which other stores those who identify as loyal shoppers at a particular retailer also shop. One caveat to these data is that if a shopper has switched to shopping only at Aldi, they will no longer register as a shopper of the rival stores listed below.
Of the grocery stores tracked by Prosper, Meijer sees the greatest overlap in customer base with Aldi, with 30% of Meijer shoppers having also shopped at Aldi in the 90 days prior to being surveyed. However, Meijer is present in Illinois, Indiana, Kentucky, Michigan, Ohio and Wisconsin—and Lidl does not currently appear to be recruiting staff in those states.
After dollar stores, Kroger sees the next-biggest customer overlap with Aldi. As we noted above, Kroger sees significant geographical overlap in those states where Lidl looks to be opening stores.
In Europe, Lidl has been among the most flexible of the hard discounters, bringing in brands, more fresh foods and premium own labels, and upping store sizes and product counts as a result. We have seen this flexibility in the first US stores to open, with larger store footprints, an abundance of fresh foods and a host of premium products. We will continue to update readers on Lidl’s US venture as store openings continue.
Macy’s Investor Day Focuses on North Star Strategy
In June, the Fung Global Retail & Technology team attended the Macy’s 2017 Investor Meeting in New York. Management outlined its North Star strategy, which comprises five points that will allow Macy’s to emerge a winner and drive future growth. The five points of the North Star strategy are:
1. From Familiar to Favorite: Marketing
There is a disconnect between consumers’ perception of the Macy’s brand and their propensity to shop at Macy’s. According to the company, 50% of Americans shop at Macy’s at least once a year and there are 1.5 billion visits to Macys.com each year. More than 600 million transactions are made at Macy’s in-store and online every year. While these metrics are impressive, the disconnect could be due in part to the current in-store experience, and management talked about how the company is going to address this.
On the marketing side, efforts are focused on building a narrative to close the gap between the Macy’s brand and sales in Macy’s stores and online. The company showed several videos of a new marketing campaign that will make a clearer distinction between events and holidays. Macy’s will build campaigns around the four key seasons. On the value side, there will be promotional events that are distinct, and a loyalty program will be added as opposed to a rewards program.
The loyalty program is expected to launch in the fourth quarter, and to be first rolled out to the company’s best customers, those who have a Macy’s brand credit card, and then expanded further in 2018. It will be a simple program with clear value and incentives that motivate changes in behavior. There will be tiered benefits that reward the loyalty of the company’s best customers.
2. It Must Be Macy’s: Product that Can Only Be Found at Macy’s
Challenges with product assortments and the in-store experience have weighed on the company’s performance. Jeff Gennette, the company’s new CEO, talked about “edited, elevated and exclusive assortments,” which translates to a focus on core brands and products, an elevated taste level (with curated fashion to match), and Macy’s being the only destination for private label and exclusive product.
Exclusive product comprises private brands, big brands and capsules. The goal is for exclusives to represent 40% of sales by 2020, up from 29% currently. On the private brand side, the company is taking time and cost out of the supply chain by taking less time for decision making and reducing the supplier base by 40%.
The company is also aiming to increase inventory turns, improve weekly regular-price sell-through and increase target average unit retail.
A simplified pricing structure will make it easier for consumers to shop at Macy’s. The company plans to offer a clearer value message coupled with coupons, clearance (Last Act) and off-price (Backstage) in stores. Management reiterated several times that Macy’s will remain a promotional department store—that is not going to change. The goal is to make pricing less complex and clearer.
Net sales in stores with a Backstage have seen an incremental lift of 4.6–6.4 points, depending on when the Backstage store was opened. Stores opened in 2017 are performing better than those opened in 2016. Management said that 26% of Backstage customers also shop at the main store on the same trip. The company plans to open Backstage stores in more than 40 Macy’s stores in 2017 and will scale the best solutions to base stores in 2018.
3. Every Experience Matters: Digital and Mobile
Macy’s has leading digital and mobile platforms and has had a mobile-first focus since 2014. The company’s omnichannel customers are highly engaged and are significantly more valuable than either online-only or in-store-only customers. The company’s expansion of its digital capabilities complements its brick-and-mortar portfolio.
Buy online, pick up in store has proven a successful combination of e-commerce and brick-and-mortar for Macy’s, and such transactions are the company’s most profitable. The service improves margins by cutting out shipping costs and increases sales, as many customers shop more when they get to the store to pick up their online orders. There are three important aspects to growing buy online, pick up in store:
In terms of availability, the hardest of the three challenges to conquer, most of the heavy lifting has already been done. Signage in stores and on the website has been added to promote the buy online, pick up in store service, and pickup locations have been moved to right near the front door or main entrance of stores to make it easy and convenient for customers (these areas were previously located at the back of stores).
4. Funding the Future: Value Creation
Macy’s has removed $1.5 billion in costs since 2015, while reinvesting $500 million in growth strategies. The company continues to focus on taking costs out of the business and operating more effectively and efficiently.
5. What’s New, What’s Next: Thinking Differently for Future Growth
An improved store experience in the future will encompass an edited, elevated, exclusive product; an open-sell format; Backstage; mobile and tech service improvements; buy online, pick up in store; and loyalty benefits for the company’s best customers. Management said that it has identified 20 locations to be transformed into new formats that incorporate these characteristics and that it hopes to scale the new concept.
In terms of the company’s future growth and what is next, management does not yet have all the answers. However, it knows that the way to get back to growth will require a different way of thinking than in the past.
Walmart: Takeaways From 47th Annual Shareholders’ Meeting—Plus Reviewing Recent Acquisitions
In June, the Fung Global Retail & Technology team attended Walmart’s 47th Annual Shareholders’ Meeting in Fayetteville, Arkansas, near the company’s headquarters. And across the first half of the year, Walmart made acquisitions of specialized e-commerce-focused retailers. Here, we note some of the initiatives discussed at the Shareholders’ Meeting and we review the recent acquisitions.
While US retail has been dominated by stories of struggling legacy retailers, Walmart has continued to grow solidly. On May 18, the company posted its 11th consecutive quarterly increase in US comps, and it reported US e-commerce revenues up fully 69%.
1. Walmart Is “Moving in the Right Direction”
Walmart Chairman Greg Penner said that the company is moving in the right direction, following 11 consecutive quarters of positive US comps and strong performances at Sam’s Club and in e-commerce. Penner said that customer feedback is improving and he characterized Walmart as being well positioned to withstand the tectonic changes happening in retail. The company stands to benefit from the $2.7 billion it invested in raising wages and in training as well as from the acquisition of Jet.com.
2. Walmart’s Financial Framework Calls for Growth and Wise Spending
CFO Brett Biggs reiterated the company’s goals regarding its new financial framework, which consists of strong, efficient growth, operating discipline and strategic capital allocation. These goals essentially boil down to two main points: grow comps and spend money more wisely. Biggs showed that SG&A expense has increased as a percentage of revenues over the past three years. He noted that a 1% reduction in annual expenses would mean an extra $1 billion that the company could pass on to customers in the form of lower prices or invest in technology, e-commerce or employees.
3. Walmart Is Implementing New Delivery Methods Such as Click and Collect
Management lauded the introduction of online grocery pickup (click-and-collect) in the US and said that shoppers can receive their items in 60 seconds with automated pickup. The company has been providing grocery delivery for 19 years in the UK and for 16 years in Japan, and now offers pickup and delivery options in eight of its 11 markets. Selected customers in Mexico and Canada can receive fresh produce delivered to their door in one hour, and New Dada, the company’s delivery partner in China, has 3 million drivers. Pharmacy customers will soon be able to use Express Lanes. Moreover, with Scan & Go, Walmart and Sam’s Club customers can scan products in their shopping cart with either their smartphone or a handheld scanner to save time when checking out. Walmart Pay, which was launched in just 18 months by a 180-person team, was also lauded as a time saver. The company has recently been testing a program whereby Walmart employees can drop off packages to customers on their route home.
4. Walmart Is Working to Improve Price Gaps on Private Label
Management commented that it has made good progress on the private label front and that private label will remain an important part of the physical and digital product mix in the future. While metrics such as complaints per million have improved, Walmart said it is about one-third of the way on its private label journey. At UK-based Asda, private label items account for about 47% of sales.
5. Strong Fiscal 1Q18 Results Were the Result of Two Years of Investment
First-quarter results benefited from wage investments instituted two years ago as well as from lower inventory, better management of markdowns and lower expenses (due to lower inventory). These factors gave the company the opportunity to “step on the gas” in e-commerce in the quarter. In addition, Walmart was able to mirror SKUs between Walmart.com and Jet.com, and to expand its marketplace to 50 million items from 10 million previously. Management commented that it was committed to growing gross margin dollars and not necessarily gross margin percentage, and that there are several opportunities to reduce SG&A expenses as a percentage of revenue.
Acquisitions Set to Underpin E-Commerce Growth
Walmart has been on a shopping spree of its own, snapping up e-commerce companies Jet.com, ShoeBuy, Moosejaw, ModCloth and Bonobos. These moves signaled a shift from organic growth to acquisition-led growth in Walmart’s e-commerce strategy.
Walmart acquired online marketplace Jet.com for $3.3 billion in August 2016. While Jet.com was not profitable, its gross merchandise volume (GMV) had reached a run rate of around $1 billion at the time of acquisition. Moreover, Walmart was able to bring on board Mark Lore, the Founder and CEO of Jet.com, to take the helm of Walmart’s online business.
Walmart’s subsequent acquisitions have focused on apparel. This looks to be driven by the growing pressure it has faced from Amazon. Clothing and footwear sales made through Amazon US totaled around $13 billion in 2016, up from around $4 billion five years earlier, according to Euromonitor International estimates.
It is too soon to see the impact of some of these recently added services on Walmart’s performance results. However, in its first-quarter earnings report, Walmart noted a 63% surge in e-commerce sales and a 69% jump in e-commerce gross merchandise volume (which includes sales by third-party sellers). The company also noted that most of this growth was organic through Walmart.com, which suggests that investments, rather than acquisitions, are driving its e-commerce growth.
Even apart from these topline rewards, we think these kinds of investments and initiatives from Walmart should be welcomed, as they reflect a highly innovative and flexible approach to adapting to a new era of retailing.
Which Australian Retailers Could Lose Out to Amazon?
In April, Amazon finally confirmed long-standing rumors that it will launch a full offering in the Australian market, although it did not specify when. In March and April 2017, the company was reportedly scouting for its first distribution center in the country, which could suggest a launch by mid-2018.
Australian consumers already shop at Amazon through its international sites such as Amazon.com in the US, and Amazon already enjoys an 8% share of Australasian (Australia and New Zealand) Internet retail sales, according to Euromonitor International.
We estimate Amazon could be generating total sales of around A$4 billion in 2021 and A$10 billion in 2026. This includes sales made by third-party merchants on Amazon. We break these estimated sales down by category later in this section.
Amazon Will Drive E-Commerce Penetration to Build Share
E-commerce tends to develop along a pathway that extends from products that are bought on specification, such as media players and electronics, to products that some shoppers like to touch or test before buying (such as clothing that they want to try on), to products that a large proportion of shoppers want to be able to touch and see before buying, such as fresh produce. We expect Amazon to accelerate Australia’s progression along this pathway by enticing more shoppers to shop online for categories such as apparel.
So, what does this mean for retailers?
Amazon will build scale in electronics: In the near term, Amazon can build scale through the electronics category, and we think this is likely to come at the expense of stores such as JB Hi-Fi, The Good Guys (acquired by JB Hi-Fi in 2016) and Harvey Norman; we chart their market shares below. Amazon could steal share from some rival Internet pure plays, too.
Amazon will drive the migration of categories online: In the medium term, Amazon stands to gain by driving online penetration in those categories that are positioned further along the e-commerce pathway. We expect this to come primarily at the expense of store-based retailers and, in particular, undifferentiated specialists that focus on third-party brands.
Amazon’s Prime membership scheme is a major lever for encouraging shoppers to switch to online buying for categories such as apparel, beauty products and groceries.
Undifferentiated Generalists Stand to Lose Market Share
We expect undifferentiated retailers that grew by selling a wide selection of other companies’ brands in big stores to be squeezed by the growth of Amazon. This is likely to include midmarket department stores such as Myer, value department stores such as Big W and Target, and mixed-category retailers such as Harvey Norman. We fear that Big W, which has seen total sales fall in recent years, may simply be the canary in the coal mine for the Australian general merchandise sector.
A Triple Threat to Margins
Any significant loss of sales by incumbent retailers will impact these companies’ margins. And we see other threats to their profitability, too:
Estimated Sales by Category
So, how big is the threat? As we noted earlier, we think Amazon could be generating total sales of around A$4 billion in 2021 and A$10 billion in 2026. This includes sales made by third-party merchants on Amazon.
Below, we provide our ballpark estimates of how those revenue figures could split out. We base these estimates in part on indications in company filings and figures from market research firms. Our estimates assume that Amazon will shift its sales mix away from electronics and media and toward apparel and grocery between 2021 and 2026.
In the table below, we also show major retailers that look likely to face competition from Amazon within each category. Retailers that focus on selling third-party brands will have the greatest overlap.
Kaufland Could be the Next Retailer to Move Into Australia
According to a number of media reports in March, German discount hypermarket chain Kaufland is set to be the next international retailer to launch in Australia. The company told us that it is only scoping the market, saying:
We are currently reviewing the Australian market in terms of potential market entry. We [will] examine the competitive situation, … the real estate market, as well as the situation in the labor market. Only after completion of [these] studies are we in a position to decide a possible market entry.
Kaufland is currently advertising on its website for locations. The company is owned by Schwarz Group, the biggest retailer in Europe. Schwarz Group is a privately owned German company that also operates Lidl discount supermarkets.
Here, we discuss the tailwinds that could drive Kaufland’s expansion in Australia and the headwinds the company could face there. We begin with some key facts to introduce readers who are unfamiliar with Kaufland to the company’s operations.
Kaufland has built scale by serving customers in less affluent regions. Prior to its East European expansion, Kaufland piled into the eastern states of Germany following reunification in 1989. Australia would be the first new market for Kaufland outside Eastern Europe—and, so, its first entry into a developed retail market.
Tailwinds in Grocery: A Sector Duopoly and Consumer Appetite for Discounters
We see opportunities for Kaufland to capture grocery market share from incumbents in a supermarket sector that is characterized by an unusually low level of competition. Two retailers, Woolworths and Coles, account for almost 70% of Australian supermarket sector sales, making the sector among the most concentrated in developed retail markets.
Moreover, Woolworths and Coles enjoy margins of nearly 5%—higher than the margins of major grocery peers such as Kroger in the US and Tesco in the UK. These margins suggest that the leading Australian grocery retailers may not be feeling the same level of competitive pressures as their peers elsewhere do.
Media reports indicate that Australian consumers perceive that they pay high prices for groceries. Based on crowdsourced food-price data from the Numbeo database, we calculate that Australians pay 22% more for their groceries than do consumers in the UK and 14% more than in Germany. However, we calculate that Australians typically pay 14% less than consumers in the US do.
Those higher prices could make Australia fertile ground for strongly value-led grocery retailers such as Kaufland. Aldi, which launched in Australia in 2001, and Costco, which entered the country in 2009, have already tapped this market succesfully, suggesting that Kaufland could succeed with a discount food and nonfood offering.
Headwinds in Nongrocery: A Crowded Mixed-Goods Sector and Consumers’ Move to Online Shopping
The other side of the coin to opportunities in grocery is the relatively crowded nongrocery space: Australia is home to a significant number of value-focused general merchandise retailers. Like most hypermarket retailers, Kaufland has a substantial nongrocery offering.
Kmart (owned by Wesfarmers), Big W (owned by Woolworths) and Target (also owned by Wesfarmers) hold strong leading positions in Australia, although Big W has posted declining sales in recent years. Furthermore, e-commerce is capturing an ever-greater share of nongrocery sales in categories that range from electronics to apparel to home goods. And we expect Amazon’s market entry to boost the migration of sales online, as we discuss elsewhere in this report.
Kaufland would therefore be adding space to a nongrocery market that could already be facing overcapacity in the coming years: i.e., too many stores fighting for share in a dwindling or low-growth market.
In other markets where rival channels have eaten into hypermarket sales (notably, the UK), the result has been lower store productivity and consequent downsizing of space in the sector.
In addition, we note the following challenges:
Making Kaufland Work in a Developed Retail Market
As we noted earlier, Kaufland has so far expanded only into Eastern Europe, where it has played a part in modernizing and consolidating faster-growing sectors. Its ability to build share in a developed, consolidated retail market (other than its home market of Germany) is so far untested.
Availability of Space
Kaufland’s requirements for large plots of up to 20,000 square meters could make finding locations difficult. According to a representative of Colliers International who was quoted in The Sydney Morning Herald in March 2017, Kaufland could struggle to find prime locations.
Tapping a Smaller Retail Sector
The total Australian food retail sector was worth A$122.3 billion (US$135.3 billion) in 2016, according to the Australian Bureau of Statistics. This is equivalent to just under half the value of the German food retail sector and it is around two-thirds the size of the UK food retail sector, we calculate, based on national statistics data. Kaufland would therefore be aiming to claim share in a market with less total potential.
Retail Formats Flowing Across Borders
In April, we attended the World Retail Congress 2017 in Dubai. One key takeaway was the flow of retail formats and shopping behaviors between the US, Europe and China.
From the US to Europe: Department Store Discounting
According to Manny Chirico, Chairman and CEO of PVH Corp., US consumers are programmed to buy on sale—and we are now seeing the “Americanization” of European consumers in this respect.
PVH Corp. is an apparel brand owner consisting of three segments: Heritage Brands (which includes Van Heusen and Speedo), Calvin Klein and Tommy Hilfiger. Its premium brands are wholesaled to retailers and sold directly to consumers worldwide.
Chirico noted three characteristics of the US retail sector that impact PVH Corp.’s brands:
In the US, the company continues to invest in its own store network, e-commerce sites and expensive flagship stores in order to support its brands, Chirico said, although these entities do not necessarily turn a profit.
Chirico said that European retail is distinct from US retail, and he noted the following features of the European market:
From Europe to the US: Grocery Discounters
As we discuss elsewhere in this report, grocery discounter Lidl has just opened its first US stores, joining rival German discounter Aldi, which has been in the US market for four decades and which is currently ramping up store-opening plans.
At World Retail Congress, the former CEO of British supermarket chain Morrisons, Dalton Philips, offered his thoughts on the discounters that he had fought unsuccessfully while at Morrisons. It was a battle that ultimately cost him his job. Philips noted that:
Meanwhile, the former CEO of Lidl, Karl-Heinz Holland, made several observations about Lidl’s growth:
From China to the Rest of the World: New Omnichannel Formats
Dr. Victor Fung, Honorary Chairman of Li & Fung, under the Fung Group, noted that retail trends will increasingly filter out from China to western markets.
The Chinese consumer is becoming the most discerning and discriminating shopper in the world. The impact of Chinese consumers on retailing is shaped by three factors: First, the Chinese consumers who are spending money are, on average, 10 years younger than their counterparts in the West. Second, Chinese shoppers are highly tech enabled and web enabled. Third, China’s high outbound tourist numbers mean the impact of Chinese consumers extends to retailers worldwide.
New omnichannel retail models could emerge from China, noted Dr. Fung. The Fung Group is leading the exploration of new models, strategies and technologies in its Explorium retail laboratory in Shanghai. Explorium is now accommodating incubators to nurture retail-related startups.
We also heard from executives at e-commerce giants JD.com and Alibaba Group about catering to Chinese consumers. Laura Xiong, Senior Vice President at JD.com, outlined how her company is serving shoppers and how it has encouraged them to convert from offline shopping to online shopping:
Guru Gowrappan, Global Managing Director at Alibaba Group, also noted some characteristics of the market and how his company is serving shoppers:
We cover Alibaba’s strategy in more detail elsewhere in this report.
Zalando Cites Multiple Growth Levers
In June, the Fung Global Retail & Technology team attended a warehouse tour and Capital Markets Day event hosted by Germany-based online apparel retailer Zalando. Here, we wrap up our key takeaways from both events.
Strategy Highlights: Moving Beyond Retailing
Guidance and Targets: Doubling Gross Merchandise Volume (GMV) by 2020
Zalando pursues profitable growth at scale. It continues to prioritize revenue growth over margin growth in the near term. Birgit Haderer, SVP of Finance, said that Zalando expects revenues to grow at two to three times market growth rates, and that it expects EBIT to grow strongly in absolute terms. The company will seek margin expansion when its revenue growth is in line with the market and, thereafter, it expects a 10% EBIT margin in its traditional wholesale segment.
The company expects to grow fiscal 2017 revenues at the lower end of the 20%–25% range and GMV, which includes third-party sales, at the upper end of that range.
Haderer emphasized that the company’s goal is to double GMV by 2020, supported by the Partner Program. Between 2018 and 2020, the company expects to grow sales by a CAGR of 20%–25%, with revenue at the lower end of this scale and GMV at the upper end. The company will start breaking out GMV once it becomes material.
Warehouse Tour Key Takeaways
We attended a tour of Zalando’s distribution center in Mönchengladbach, Germany, that the company hosted the day before the Capital Markets Day event. Our key takeaways from the tour include:
Amazon is sometimes cited as a potential threat to Zalando, but we found that the presentations at Zalando’s Capital Markets Day collectively underlined how different these companies are in the apparel category.
With €3.6 billion in revenue last year and a target of hitting total sales (including by third parties) of €10 billion by 2020, Zalando is the largest retailer in Europe for many major apparel brands—and it appears to be a desirable partner, given innovations such as its exclusive ranges and Partner Program. We therefore view Zalando as a differentiated operator with scale.
Takeaways on Artificial Intelligence, Conversational Commerce, Virtual Reality, Augmented Reality and Blockchain
In February and March, the Fung Global Retail & Technology team attended the Mobile World Congress 2017 in Barcelona.
Retailers in e-commerce and brick-and-mortar are investing heavily in AI technology. AI can serve as a personal assistant to consumers, helping them perform daily tasks, such as shopping, and examples here include Alexa, Clove and Google Assistant. And AI is enabling conversational commerce online.
Conversational commerce refers to a messaging application that enables shopping, customer service or inquiries. Through AI and natural language processing, a chatbot can mimic human interactions to give consumers access to more information and greater service online.
Retailers are engaging their customers not only through their websites, but also on their social media accounts. We met with firms such as Conversocial, which helps companies identify customers that require service via scanning social media platforms and offer customer service on social media using chatbot technology. The company’s cofounder and CEO, Joshua March, told us that he believes AI will likely revamp the entire customer service industry in the next 3–5 years.
John Pulver, an Internet entrepreneur, presented on Chatbots and commerce, and noted that 63% of people engage with companies through text or messaging and out of those interactions, 50% are handled by bots. For Pulver, the future belongs to the further automation of these interactions. However, the evolution he is expecting is that rather than using text, people will move on to use voice to converse with machines. In fact, he commented that Gen Z will shift to voice communication from the current textual norm, and that AI technology, such as Amazon’s virtual assistant Alexa, will play a big role in that.
Many companies showcased VR or AR content at Mobile World Congress, yet the quality of the content varied greatly depending on the hardware. We believe this year most consumers will experience VR/AR first-hand for the first time, given the lower costs and with better accessibility.
A number of speakers agreed that we are likely to see standalone head mounted display (HMD) VR devices later this year as the next step in the evolution of mobile VR hardware. However, the technology is still bound by limitations of GPU speed, display capabilities and batter life preventing it from being made available through a standalone mobile device that allows freedom of movement and use over a prolonged period of time.
Hugo Swart from Qualcomm discussed his view that the future of AR and VR is for the technologies to converge from a user experience point of view―entire scenes of digital content will be accessed through a mobile device with a quality that will be nearly indistinguishable from reality, while full VR immersion is likely to become just one “mode” of the technology that will be used occasionally. In this sense, VR and AR hold great promise to augment reality as we know it. However, all experts seemed to agree that this future is still a long way out.
We experienced Google’s Tango technology in retail: the customer makes a product selection and the digital item is superimposed on the physical environment in accurate proportions and correct orientation via AR. The technology worked smoothly and the experience benefited from the display qualities of Google’s new smartphone. In this use case, AR technology on mobile allows customers to browse, view and purchase a much wider range of products than the retailer physically has in stock.
JP Rangaswami, Chief Data Officer at Deutsche Bank observed that there has been a fundamental shift from sellers’ markets, where market transactions are defined by a single provider to many agents, to distributed, or network, models, where the agency is in the hands of consumers. The blockchain is one example of this. It offers an alternative to centralized book-keeping and verification of virtual transactions and assets. Rangaswami concluded that organizations much adapt to this power shift from centralized organizations to consumers.
Brock Pierce, Managing Partner and Chairman of Blockchain Capital, discussed his view on the opportunities that blockchain technologies present for entrepreneurs and corporates. In his view, blockchain technology is probably the most important technology after the Internet, as it will democratize access to financial services to a large demographic in the currently underserved developing and emerging markets. Furthermore, blockchains and, more specifically, the tokens used to transact on blockchain infrastructure, are likely to revolutionize the way businesses get started and how they raise capital. In 2016, there were 64 ICOs (Initial Token Offerings), which raised over $103 million, and, in some cases, funding rounds were raised in minutes—for example, Golem raised $8.5 million by selling tokens in 19 minutes and SingularDTV raised $7.7 million in 17 minutes.
US Retail Sales and Macro Review
In this section, we summarize key US economic metrics including retail sales.
The US economy decelerated in 1Q17, negatively affected by unconventionally warm weather and delays in tax refunds. At the same time, the housing market continued to grow, contributing 0.5% of the 0.7% GDP growth. The US unemployment rate also hit a 10-year low in April, at 4.4%, pointing to a resilient job market. Overall, we believe the slowdown in the first quarter will not extend into the rest of the year, as strong fundamentals and a strong housing market look set to support economic growth.
The stream of negative news stories on US retail conceals solid growth across the sector as a whole. Total sales ex gas were up fully 5.3% in May (latest). However, general merchandise, apparel and furniture stores (GAFO) have underpaced total growth.
GDP growth in 1Q17 slowed to its lowest level since 2Q14, at 0.7%, from 2.1% in 4Q16 and 1.1% in 1Q16, missing the consensus estimate of 1.2%. The weakness can be attributed to following factors:
We expect the weak performance of 1Q17 to be a one-off, and do not expect it to persist into the rest of the year. The strength of the housing market and the low unemployment rate suggest that the economy is fundamentally resilient.
The US job market had its strongest quarter in 1Q17 when compared with the past 10 years. The unemployment rate hit its lowest level since May 2007, dropping to 4.4% in April.
Nonfarm payroll was 211 in April, rising from 79 the previous month and higher than 153 in April 2016.
The US economy added 211,000 jobs in April, beating the 190,000 consensus estimate. This drove the unemployment rate down to 4.4%.
US consumer sentiment increased to 97.0 in April 2017, from 96.9 the previous month and 89.0 in the year-ago period. The higher figure is the result of the strong US job market and reflects consumers’ firm confidence in the economy.
In summary, total retail sales growth has continued to prove robust and the macroeconomic fundamentals bode well for this to continue.
The Alibaba Economy and the Opportunities to Grow
In June, the Fung Global Retail & Technology team attended Alibaba Group’s 2017 Investor Day at its headquarters in Hangzhou. Here, we wrap up presentations from CEO Daniel Zhang and Executive Chairman Jack Ma.
CEO Offers a Strategic Perspective on the Alibaba Economy
Daniel Zhang presented an overview of Alibaba Group’s ecosystem and the company’s future strategy. Alibaba has been evolving rapidly since it was founded in 1999. Zhang highlighted that Taobao will remain an important platform within its core commerce segment—it has transformed from a marketplace to become a social commerce platform, allowing consumers to have fun exploring. The company has also moved into new areas such as digital entertainment and local services through investments in Koubei, a local commerce platform, and ele.me, an online food delivery platform.
New Retail: Digitizing the Core Components of Retail Operations
Alibaba Group aims to digitize the different stages of the value chain, and has been experimenting with New Retail across different retail formats at its strategic partners such as Intime, Suning.com, Sanjiang and Bailian. Zhang regards Alipay, which provides digital payment solutions for offline retailers, as important, as it helps give consumers a seamless experience both online and offline, and is being integrated at physical retailers.
Zhang highlighted significant transitions in retail:
Chairman’s Speech: “Born in China, Grow for the World”
Jack Ma expressed his vision for Alibaba and the two major opportunities—globalization and China’s consumption upgrade—that he has been witnessing. He wants to focus not merely on the next quarter, rather on his long-term vision for the group—to become a truly global company providing solutions to world problems. He believes Alibaba can help globalization by making trade more inclusive, and e-commerce is the best way to solve that.
Ma expects Alibaba’s gross merchandise volume (GMV) to reach US$1 trillion by 2019, serve 2 billion customers—one-third of the world’s total population—by 2036, and support 10 million profitable businesses on its platform economy.
Making Globalization More Inclusive
Ma expects the new global economy to be based on the Internet. He views globalization as a huge opportunity for Alibaba and expects its cross-border e-commerce platforms—Lazada and AliExpress—to grow rapidly. At Davos, China’s President Xi Jinping said China will import US$8 trillion in the next five years.
Alibaba is building a global network to leverage the network effect. By making the network available for all companies to join, Alibaba is making global trade more inclusive and leveling the playing field between large and small companies.
The eWTP (Electronic World Trade Platform) is a concept to create digital free-trade zones where small and medium-sized enterprises (SME) can tap into global trade via e-commerce. Malaysia was the first country to join in March 2017, and Alibaba is inviting more countries to join.
China’s Consumption Upgrade
Ma believes Alibaba is well positioned to benefit from the structural trends in China: 1) a growing middle class; and 2) the country’s shift from an investment- and export-led economy to one that is driven by domestic consumption. First, there are over 300 million middle-class consumers in China today, and this number is expected to increase to 500 million in the next five years. Second, Ma believes e-commerce will play a major role in China’s consumption upgrade, which is expected to drive import growth.
The Five “New”
Ma discussed the concept of the five “New,” which he believes will drive the Chinese economy in the future.
Ma expects Alibaba’s gross merchandise volume (GMV) to reach US$1 trillion by 2019, serve 2 billion customers—one-third of the world’s total population—by 2036, and support 10 million profitable businesses on its platform economy.
5,321 US Store Closures Announced So Far This Year
Each week, Fung Global Retail & Technology tracks store openings and closures for a selected group of US retailers. We published the data in this section on June 23.
What Happened This Week?
Amazon to Acquire Whole Foods
Amazon announced that it has reached a definitive agreement to acquire high-end grocery chain Whole Foods Market for $13.7 billion in cash. The acquisition comes at a difficult time for physical retailers, but many see the current environment as an opportunity for e-commerce players to move offline. Assuming that no changes are made to the Whole Foods store fleet, Amazon will add more than 460 Whole Foods grocery stores to its list of physical stores. We cover the acquisition in more detail elsewhere in this report.
Private Equity Firm Sycamore Partners Close to Acquiring Staples
Private equity firm Sycamore Partners is in advanced stages of discussions with US office supplies retailer Staples regarding a deal that will see the retailer go private. The deal could be worth as much as $6 billion, according to reports from Reuters. Staples has more than 1,200 stores in the US and around 300 in Canada. No official comment has been made by either party, as the deal negotiations are still under way privately.
Bebe E-Commerce Platform Reemerges
Bebe will be selling on its e-commerce platform again, just a few months after it declared bankruptcy. The transformed e-commerce platform, with international brick-and-mortar stores, will be operated by Global Brands Group. The brand will continue to focus on chic women’s fashion, which has always been its differentiating factor.
Sports Direct Completes Acquisition of Eastern Outfitters
UK retailer Sports Direct has completed its acquisition of Eastern Outfitters, which operates under the Bob’s Stores and Eastern Mountain Sports brands. The new owner will operate 50 physical stores in the Northeastern US, along with five Eastern Mountain Spo rts outdoor adventure schools and corresponding websites.
The chapters in this report have been condensed from our full-length reports, and we have updated key data where necessary. The following reports correspond to the numbered chapters in this report. They can all be found on our website, FungGlobalRetailTech.com